None dare call it conspiracy

Author: Tony Bell, Head of International Investments, Vunani Fund Managers

With so much focus on Covid-19, it seems the world of investment commentary has missed a few links into what else may be unfolding. While VFM does not subscribe to conspiracy theories, there are several observations to be made regarding the current rally in equity prices globally that may be of interest.  In our investment process, we focus a great deal on the use of inference to establish what the market has priced in. Over the past few months, many fixated on the impact of Covid-19 on the broader economic outlook. This seemed entirely rational as a feed through to company earnings. Yet, a number of sectors and company’s are hitting new highs. Why?

Many years ago Allen & Abraham published a book entitled “None Dare Call It Conspiracy”. Chapter 3 deals at length with the “money manipulators” during WWII. Clear evidence exists today of money manipulation under cover of the current pandemic. Of course, it has a most acceptable name, Modern Monetary Theory. Have we seen it before? Yes, Roosevelt used in in the 1930s to create a “beautiful” deleveraging by devaluing the dollar vs gold. Japan has followed the approach at least twice as have Germany and the UK. History is replete with examples where monetary debasement financed wars or created empires. Examples include 16th Century England, the US Civil war, Imperial China, and the debasement of Ancient Rome. In essence, central banks expand the money base to provide printed money directly to the government, buy virtually any asset, and provide printed money directly to households. The objective is to decrease the value of the currency, import inflation and engineer a deleveraging through fiscal repression.  Under this regime, governments compete for capital from investors as currency movements play an ever-increasing role in cross border returns and trade tensions move from the political to currency arena. To place some perspective on the numbers, Since the start of the pandemic central banks have added nearly $11tn of new money and pushed debt levels to previous WWII peaks.

The critical question is whether this newfound appetite for QE4 will resolve the economic growth problem. Sadly, in this environment, the transmission mechanism for normal economic activity to resume is limited as lenders don’t feel confident, and borrowers don’t borrow. The puzzle that the world’s policymakers will have to solve in the months ahead is how to channel this new money through productive channels. Companies linked to the “new world” of virtualisation are likely to continue to do well. The key to understanding the investment case for each company is to review the capital allocation cycle, not just earnings and valuation. Companies that can covert free cash flow into a higher return on equity through adapting product offering and distribution channels continue to take market share away from those that can’t or won’t adjust. A new order is emerging where yields remain suppressed for longer, currency devaluations become the new “game”, and broad-based recovery is deferred for some time as capital formation struggles to normalise. The hidden risk in all of this is inflation. Larry Summers may not be the next treasury secretary, but he may well be right in his theory about long term stagflation.